Risk Management in Public-Private Partnerships – India’s Experience

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Research Intelligence Unit – www.riunit.com


The main purpose of initiating public procurement is to provide adequate service quality at affordable costs. Additionally, public procurement can also be used for obtaining value for money by ensuring that projects are awarded in a competitive environment. Ensuring that economic appraisal techniques such as the proper calculation of appreciation are applied rigorously along with appropriate allocation of risk between the public and private sector that will maximize service value are also critical for securing a successful public private partnership (PPP) approach. In terms of the success measurement yardstick, comparisons between publicly and privately financed options need to be fair, realistic and comprehensible. Politics and ideology should not be entered into the equation.

Essentially, when embarking on a fresh PPP initiative, it is vital that an appropriate and conducive framework for infrastructure delivery is developed by optimizing public and private sector roles through a committed long-term partnership with a focus on capacity and financing. Sri Lanka is not quite there.

PPP’s imply a very different approach to doing business. It involves a gradual, but fundamental shift in focus of the public sector agency away from execution of works to planning and management of activities. PPP’s also require sufficient capacity on the part of the private sector to deliver expected efficiency gains.

The Research Intelligence Unit facilitated a seminar and workshop funded by the Commonwealth Secretariat and the Board of Investment on PPP’s and ways to address the infrastructure issues in Sri Lanka during August 2006. Many of the distinguished resource persons making presentations, including Lise Wiedner, a risk management specialist from Manila, Philippines, drew from the lessons learned in India.

Indian National Highways

The Indian National Highways Development Project (NHDP) I and II involves strengthening and upgrading to four or six lanes the highway density corridors. Under the program referred to as the ‘Golden Quadrilateral’, the project will connect the four metros of Delhi, Mumbai, Chennai and Kolkata. The 14,702 kilometer exercise, worth some $15.1 billion was 95 per cent completed by December 2005.

The National Highways Authority of India (NHAI) was established in 1988. The National Highways Development Project (NHDP) I and II were subsequently initiated in 1998, backed by strong political support. PPP supportive policies and conducive regulatory and institutional frameworks were also developed at the time. A system of ‘one time’ program approval mechanisms where project by project approval was not required was also introduced for the sake of expediency. Instituting a ‘Road Fund’ via the introduction of cess on petrol and diesel as well as the development of a model concession agreements formed part of the overall strategy adopted by the NHAI.

Contract and financing modalities

Private sector involvement in the financing, development, operation and maintenance of the national highways was based on build-operate-transfer (BOT) concessions in a number of forms. These included toll based BOT concessions for roads with high traffic estimates, annuity concessions for roads with medium and / or uncertain traffic estimates and special purpose vehicles (SPV) for port connectivity projects.

By May 2004, six years after the setting up of the program, the PPP initiative had resulted in the construction of 477km of roadways under annuity concession agreements, 452km constructed under toll based BOT concession agreements and 383km of SPV agreements. The aggregate total length of roads constructed under PPP structures was 1,312km, amounting to nine per cent of the 14,702km planned under the NHDP.

Several financing options were used by the NHDP. Where revenues from tolls are not considered sufficient but the estimated traffic is considered high, financial support in the form of an upfront construction cost grant has been used. These upfront grants that can cover up to a maximum of 40 per cent of total construction costs are typically disbursed from public funds that are allocated under a toll based BOT concession.

Where the road traffic risk is too high and cannot be transferred to private sector hands, annuity payments can be made that are transferred from public funds to the private party upon completion of the asset construction. In the case of SPV’s, that are applicable in port connectivity projects, the equity co-sponsors have been port authorities themselves.

Traffic, tolling levels and cost estimates are the principal parameters at the project level. At the strategic program level, the government can decide the forms of financial viability gap funding it wishes to offer to private participants. These choices are based on a number of factors, including fiscal space, availability of dedicated revenues such as from a road fund, and the degree of risk the government is willing to retain.

Annuity concessions and traffic risk

The key point to consider when deciding on a level of annuity concession is the prequalification criteria linked to the bidders experience and financial capability. The request for proposals contains the detailed project report, the draft concession agreement and technical, financial and legal specifications. Additionally, following the technical evaluation, the preferred bidder is selected on the basis of the financial proposal requiring the lowest annuity payments from NHAI.

NHAI’s payment obligation materializes only upon successful completion of the road to standards that are in accordance with the predetermined quality requirements pertaining to both the physical road assets as well as the service to the users of the road. A single point contractual responsibility for both construction and operation of the roadway functions as a strong incentives to monitor construction with a view to minimize subsequent operations and management costs.

Traffic risk, as given by the right to levy tolls or fees on the project road, is retained by the NHAI. The risk of higher maintenance costs due to higher than expected traffic is borne by the concessionaire, and output specifications for performance have significantly reduced NHAI supervisory requirements and resulted in cost savings. According to a study conducted by Standard and Poor, only 70 per cent of estimated traffic actually materializes. In countries where traffic data is limited and tolls have not been applied, it is extremely difficult to transfer the entire traffic risk to the private sector at a reasonable cost.

Implementation Experience

Since May 2004, 78 projects were under implementation, 31 projects were delayed, 30 out of these contracts were engineering, procurement and construction (EPC) contracts and one was in SPV. None of the annuity concessions or toll based BOT were included in the list of delayed projects. Analysis demonstrates that there were significant cost and time delays for the EPC contracts under the GQ. NHAI bears the risk for these delays. Nevertheless, in conclusion, it can be stated that the risk transfer in the PPP contracts were balanced and did deliver efficiency gains.

A meeting chaired by the Prime Minister of India on 15 March 2005 decided that ‘As regards the issue of EPC versus BOT contracts, it was agreed that for ensuring provision of better road services, including high quality of construction and maintenance as well as the timely completion of projects sans the cost and time overrun, contracts based on BOT models are inherently superior to the traditional EPC contracts. Accordingly, it was decided that for NHDP Phase III and onwards, all contracts for provision of road services would be awarded only on a BOT basis, either based on toll or annuity, or a suitable toll/annuity hybrid, with EPC awards being made in specified exceptional cases only” (Report of the Core Group – Financing of the National Highways Development Programme, section 6.2.1, Published by the Secretariat for the Committee on Infrastructure, Planning Commission, Government of India, 2006.)

Lessons to learn

By contrast to India’s positive record over recent years, Sri Lanka’s failure to develop its infrastructure continues to be a thorn it its economic development. Typically, time wasting at various stages of projects results in them out-lasting elected governments. On the arrival of new governments and policy regimes, many ongoing projects are dismantled as the new government in power works to initiate new activities. The vicious circle of wastage continues to hold down the island’s power, transport and road sectors whilst an expressway linking the international airport to Commercial capital is still missing.

During his address at the PPP Conference in August, Secretary to the Finance Ministry stated that Sri Lanka has a huge investment potential and that private sector participation in infrastructure development would be supported by the government. He further added that private sector would be invited to invest in the north and east of the island as part of the peace building strategy.

In the absence of any serious improvement, onlookers will continue to wonder as to how such a massive amount of time and resources has been wasted in this country and how Sri Lanka can spend six years building 15km of road and why we toil for 15 years to construct a 300MW power plant.

Copyrights Reserved (RIU 2006). Compiled exclusively for the Business Standard.